Azerbaijan as a middle-income country

Rustam Jamilov

Research Fellow, Central Bank of Azerbaijan

Lecturer, Azerbaijan State Economics University

Having recently celebrated the 20th anniversary of its independence, Azerbaijan is engaged in comprehensive reflection. After going through a stage of conceptual and institutional formation during the 1990s and a rapid transformation into a market-oriented economy during the 2000s, the country is evaluating its past and looking forward to the future, with many asking questions like: has Azerbaijan fully achieved the status of a middle-income country? In order to review Azerbaijan’s accomplishments and ongoing challenges, this essay analyzes a set of aggregated economic and socio-demographic rankings and then discusses Azerbaijan’s progress through the prism of income group classification.

In addressing this issue, we first need to determine whether Azerbaijan even qualifies, according to standard rules, as a middle-income state. If so, then we will expand the topic to consider those features a typical middle-income nation should possess. We will therefore set up certain criteria, common to a typical middle-income state and evaluate Azerbaijan on the basis of those standards. Apart from merely meeting the statistical criteria of aggregate demand and production, there are certain institutional, economic, and socio-demographic features that people typically expect from a standard middle-income country.

Those features include, but are not limited to, the general financial and business environment, regulatory efficiency and transparency, institutional maturity, accessible good-quality tertiary and higher education, and conditions of the social welfare state, among others. In evaluating Azerbaijan with respect to income groups, we will review exactly these features, thus adopting a broader-than-statistics perspective, one that will allow us to get a fuller picture as to whether Azerbaijan is really a “middle-of-the-pack” state. This approach could be called an extended or a qualitative approach to the income group discussion.

In general, income groups are traditionally defined by the World Bank according to the countries’ GNI per capita statistics. In 2010, Azerbaijan reported a 5,330 USD GNI per capita. [1] Meanwhile, the World Bank’s minimum criterion for entering the middle-income group status is 4,900 USD, while the group average is 5,800 USD. [2] Using this measure by itself, we can argue that Azerbaijan is a member of this class, but we should not draw immediate conclusions and instead must examine additional factors. When comparing GNI per capita with that of other similar states, Azerbaijan ranks above some of its South Caucasian neighbors, Georgia and Armenia, for which the numbers are 2,690 USD and 3,200 USD respectively, but lags behind the territorially larger Russia and Kazakhstan. Azerbaijan in fact seems to be placed well with the Arab World group of countries, for which the average GNI per capita is 5,500 USD, [3] a placement entirely logical considering their similarities in terms of the internal energy-based industrial structure.

However, Azerbaijan is still behind the Developing European and Central Asian Countries and the overall worldwide averages, for which the figures are 7,200 USD and 9,800 USD respectively. [4] Perhaps, the medium-term goal for Azerbaijan should be to approach those levels, in terms of pure GNI per capita. In addition to the World Bank numbers, the CIA World Factbook ranks Azerbaijan 107th in GDP per capita in the world, which is—in very rough terms—the “middle-of-the-pack.” [5]

Now we will expand the narrative from “bottom-line” statistics of per capita economic production to a description of the overall socio-economic model by including a set of aggregated developmental indexes. First, we will examine the general macroeconomic and macro-financial environment in Azerbaijan. The country is ranked 20th among all upper-middle income states of the world according to the World Bank’s Doing Business Report, which measures the ease of doing business. [6] Azerbaijan is thus viewed as easier to do business in than Turkey, but more problematic than, for example, Kazakhstan. Furthermore, Azerbaijan ranks 10th among upper-middle income states worldwide in investor protection, fourth in starting a business, and sixth in enforcing contractual obligations.

At the same time, Azerbaijan ranks second to last in cross-border trade and is in the bottom five in terms of obtaining construction permits. Some of these, of course, especially the rank of investor protection, are significant accomplishments, which could perhaps lift Azerbaijan over most of its neighboring and fellow middle-income countries; but given the apparent presence of problems in areas such as trading across borders, the two extremes balance each other out, eventually supporting the premise that Azerbaijan is an “average” country to do business in.

Another useful comparison of countries’ economic progress is provided by the World Economic Forum’s Global Competitiveness Report. It offers a general ranking of overall national economic competitiveness and then deconstructs it into sub-category indices, such as institutional, demographic, or macroeconomic pillars. Azerbaijan ranks 55th in the world, above all the member-states of the Caucasus like Georgia and Armenia, as well as Russia, Kazakhstan, and even Turkey. A closer look at the ranking components reveals that much of the country’s success is driven by the performance in the macroeconomic and labor market efficiency pillars, where Azerbaijan ranks 16th and 14th worldwide respectively. [7] In the meantime, factors like financial market development, health, and primary education stand out as areas of weakness, pulling its ranking down. Thus, this report supports our earlier findings from the Doing Business index, as well as the basic GNI per capita method that Azerbaijan is a middle-income state.

Azerbaijan, at the end of the day, is an emerging country, still in the stage of continuous transition into a full-pledged market economy. Comparing Azerbaijan with other in-transition states could be useful. The European Bank for Reconstruction and Development (EBRD) transition index seems to be an appropriate instrument for that. [8] When looking at the 2010 across-factor accumulated averages, Azerbaijan maintains an overall score of 2.486 out of 4.0. That is greater than, for example, Belarus (1.856), another country in transition, but is below the figures for Kazakhstan (2.88) or Georgia (2.97). The divergence in ranking results between the EBRD index and the Global Competitiveness Report, reflects differences in methodology, but the gap is not substantial enough to cast doubt on our thesis that Azerbaijan is a middle-of-the-pack state.

Similar to the Global Competitiveness Report, the EBRD transition index also provides a categorical decomposition. Special emphasis is placed on government expenditure on health care, which was the lowest among all transition countries in 2008 at just 1% of GDP. Expenditure on education was also very low, 2.6% of GDP. Naturally, the GDP of Azerbaijan is significantly larger than that in countries like Georgia or Armenia, so in absolute terms, it is quite possible that Azerbaijan spends actually more on education and health care than many of its neighbors. However, there is an obvious correlation between low spending and being ranked just 105th in the world for healthcare and tertiary education.

Meanwhile, Azerbaijan has a 2% proportion of the population living below the poverty line, which is significantly better than what is the case in Georgia or Armenia, where the figures are 30% and 43% respectively. Once again, by and large, when including multiple factors into the discussion, Azerbaijan is right in the middle of the mix when it comes to country rankings. It is interesting that we are beginning to observe a tendency of positive drivers (macroeconomic stability) and negative drivers (healthcare and education, or basically, social welfare state) that respectively move the country forward and drag it back.

So far our assessment suggests that Azerbaijan can be counted as a middle-income state not just according to the World Bank’s classification, but also from a broader point of view. For further analysis, we will now look in greater detail at some of the issues and areas of concern raised by the preliminary discussion. First of all, from a basic macro perspective, Azerbaijan has enjoyed quite stable times of both economic and political stability over the past several years. These two components have led to the country achieving extraordinary growth figures in the years prior to the Global Financial Crisis, and to being ranked 16th in the world in macro stability among all upper-middle income states.

That result, however, almost entirely reflects the country’s oil boom with receipts from oil revenues coupled with high oil prices playing the roles of prime catalysts. The massive state-driven injections of money into the economy, constituting an unprecedented fiscal expansion, carried the country through the boom years. Suffice it to say that Azerbaijan grew by just 0.1% in 2011, largely due to the falling oil production and lower oil prices on world markets. [9] Overreliance on natural resources, also known as the “resource curse” can have a negative impact on Azerbaijan, which lacks industrial competitiveness in the non-oil sector of the economy and thus is very exposed to external risks. The point is that macro stability, a substantial factor for Azerbaijan being counted as a middle-income state, depends to a great extent on the oil component. Losing the comfortable ground in the energy field can potentially result in Azerbaijan watching its middle-income status lose the most fundamental building block.

Another issue is that the oil sector brings massive amounts in capital while employing few people: just over 1% of the country’s population. [10] The resulting problem is not only an economic problem, but a social one as well; one forcing the country to consider the ways in which to restructure the economy so that the oil sector will not “feed” the non-oil component, but allow the latter to grow independently of oil revenue. Naturally, initial investments to the institutional architecture should come from the oil money, but after the “kick-start” phase, the economy must diversify and expand horizontally and vertically thanks to private-driven innovation and technology-intensive production. Until Azerbaijan develops a sustainable model of long-run growth, it is counterproductive to celebrate its status of a middle-income country based on numbers alone, because that status and those numbers were accomplished by a temporary and not everlasting factor—a non-renewable resource, which will deplete in the future.

Apart from the apparent need for industrial diversification, Azerbaijan will need to place greater strategic emphasis on the further development of institutional democracy and focus on increased performance of the functions of the state and the role of civil society. [11] That includes a continuous effort against non-transparency, strategic rent seeking, corruption, and economic wastefulness. Significant efforts should be also put on ensuring an effective extension of the key components of a free market economy. For example, expansion of the capital markets and development of market stabilizing economic institutions must remain among the top priorities of governmental agencies. The issue of financial market development is particularly important: Azerbaijan today ranks 94th in the world according to the Global Competitiveness Report with respect to financial market conditions.

With regards to the issues raised above, government units should continue working very tightly with international organizations like the World Bank and the IMF in order to enable an efficient functioning of the economic institutional framework. That is because “easily appropriable rents weaken governance and institutions, increase corruption and self-interested rent seeking, and prevent economic growth.” [12] In other words, strategic rent-seeking and special interest groups make it much harder for a small developing country to step on the path of transparent and sustainable growth.

Having dealt with the institutional question, Azerbaijan should also attempt to accomplish greater efficiency in financial management, tax and regulation, bureaucracy, and ease of doing business and getting things done. Some progress has been made: because of the “one window” tax system adopted in 2008, some 23 million USD were saved in very short periods of time due to efficiency improvements. [13] However, the tax system still needs further upgrades; Azerbaijan ranks 202nd in the world in taxes as a percentage of GDP, with taxes amounting to just 11% of total economic output. [14] On a positive note, it now takes just three days to start a business in Azerbaijan, down from 30 days four years ago, just one example of how reforms in Azerbaijan may work and bring measurable dividends.

The social welfare system is probably Azerbaijan’s single most significant area that needs substantial modernization and systemic improvement. On one hand, Azerbaijan has a primary completion rate for tertiary education of 90%, exactly the average for the upper-middle income countries according to the World Bank; but on the other hand, life expectancy is 70, while for the upper-middle income states the average is 72.6, a significant gap. [15]

The Azerbaijani labor market, even if not terribly diverse, is efficient. This was suggested earlier by the rank of 16 among all middle-income states worldwide in labor market efficiency according to the Global Competitiveness Report. Even during the worst times of the recent financial crisis, the unemployment rate in Azerbaijan was 6.1% in 2008, [16] half the rates in Georgia and Armenia. On a more pessimistic note, public entitlement spending, an important component of national welfare state, is still a topic under the radar screen in Azerbaijan. Unemployment support, funding of large low-income families, pension, aid to single mothers, public medical coverage, while existing on paper, still need a great deal of improvement. With regards to unemployment support, this is actually quite logical that Azerbaijan’s labor market is functioning well. Because of the lack of a robust social safety net, there is absolutely no incentive or benefit in remaining unemployed. Therefore the individual initiative-based employment search is generally quick and productive.

In general, public assistance is not extensive, restricted to small proportions of the population, while the otherwise qualified people do not receive it. Bureaucratic requirements discourage many from even making a serious attempt to obtain support. And if support is granted, the amounts are less than adequate to live an average life even in the rural areas, let alone in the urban Baku or Ganja. Whether Azerbaijan decides to pursue a Scandinavian path towards a full welfare state is a different question, but there are some basic entitlements for which the population of a middle-income state has fundamental rights, and those entitlements should be delivered.

Development of social and human capital, or more concretely, education—both on the tertiary and the higher levels—requires modernization and both legislative and conceptual updates. Azerbaijan allocates only 2.6% of its GDP towards education spending, thus ranking 140th in the world according to the CIA Factbook. Based on this number alone we can conclude that, in the medium-to-long run, Azerbaijan will have a shortage of high-profile specialists in priority areas of development. Investment into education reform, into social and human capital, is of paramount importance for the modern Azerbaijan. [18]

One might argue that spending on education is not the only answer. Azerbaijan needs conceptual models of high-quality education. The “flag ships” of national education, although benchmarked from abroad, must be ultimately created and cultivated domestically. For example, it was not too long ago that the youth of Azerbaijan and of the region received the privilege to study at the Azerbaijani Diplomatic Academy (ADA). Since ADA’s opening in 2006, the standards of education have arguably gone through a process of major reconsideration and rethinking, with ADA leading the way in both quality of education and the strength of its research arm. The optimistic scenario lies in the belief that other higher education institutions of Azerbaijan will be following ADA’s example in training and educating the future leaders of Azerbaijan and of the world.

The basic argument of this essay is that it is not just the baseline GNI per capita numbers, which matter for being considered an upper-middle income state. Macro-analysis is about a sustainable general model, a socio-economic mentality, a long-term platform on which a country’s or a region’s growth pattern is being constructed. From a broader view in which income-groups are indirect indicators of socio-economic status and not merely a statistical rank, Azerbaijan’s membership in the middle-income group requires reforms to move toward a modern social welfare state, including improving areas like health care, education and the social safety net.

These conclusions will not be news to Azerbaijani policy makers. The new development strategy Azerbaijan 2020: Looking to the Future prioritizes many of the areas discussed above, particularly industrial diversification and development of social and human capital. Despite being at the stage of conceptual design and formation, the Strategy represents a realistic plan for Azerbaijan to become a fully-fledged upper-middle income state. Meanwhile, with a stable population and a fast-growing economy (even despite the low 2011 growth numbers), the GNI per capita can carry Azerbaijan quantitatively towards the magical 7,000 USD mark, the average for developing European and Central Asian countries.

Notes

[1] See World Bank Database, available at http://data.worldbank.org/country/azerbaijan (accessed 28 February 2012).

[2] See World Bank Database, available at http://data.worldbank.org/income-level/UMC (accessed 28 February 2012).

[3] See World Bank Database, available at http://data.worldbank.org/region/ARB (accessed 28 February 2012).

[4] See World Bank Database, available at http://data.worldbank.org/region/WLD (accessed 28 February 2012).

[5] See CIA World Factbook, available at https://www.cia.gov/library/publications/the-world-factbook/rankorder/2004rank.html?countryName=Azerbaijan&countryCode=aj&regionCode=mde&rank=107#aj (accessed 28 February 2012).

[6] See http://doingbusiness.org/ (accessed 28 February 2012).

[7] See Global Competitiveness Report, available at http://www.weforum.org/issues/global-competitiveness (accessed 28 February 2012).